1. Part 3B: Equity, Dividends & Retained Earnings
CHAPTERS
13-16
FINANCING:
Part 3B: Equity, Dividends & Retained Earnings

2. DIVIDENDS What are they?
A dividend is a return of wealth by a corporation to its shareholders on an equal basis.
Dividends may be in the form of
Cash, or
Shares

3. CASH DIVIDENDS Requirements
For a cash dividend to occur, a corporation must have:
Retained earnings,
Adequate cash, and
Declared dividends

4. CASH DIVIDENDS Preferred Shares vs. Common Shares
Cash dividends must be paid to preferred shareholders before any common shareholders are paid.
There are two kinds of preferred shares:
Cumulative: all past dividends (in arrears) must be paid before common shareholders get anything.
Non-cumulative: only the current year’s dividend must be paid before common shareholders get a dividend.

5. CASH DIVIDEND The Effects
On Jan. 1, this company declares a $0.50 dividend per share (or $50,000 total) to all shareholders on record Feb. 1. The dividend is paid Mar. 1.
This dividend represents a “drawings” on the wealth of the corporation, and is returned to the shareholders.
After a cash dividend shareholder’s equity falls.
Date
Particulars
Debit
Credit
Jan 1
Cash Dividends ,000
Before After Cash Dividend Cash Dividend
Shareholders’ equity
Contributed Capital
Retained earnings
Total shareholders’ equity
Issued shares
Book value per share
Cash Dividends Payable ,000
Mar 1
Cash Dividends Payable ,000
Cash ,000
$200,000
$200,000
Dec 31
Retained Earnings ,000
$600,000
$550,000
Cash Dividends ,000
$800,000
$750,000
Note: Like Drawings, Dividends are closed to Retained earnings in the closing entries.
100,000
100,000 $8
$7.50

6. STOCK DIVIDENDS The Effects
A stock dividend is an equal distribution of the corporation’s own shares to its shareholders.
Fair market value is usually the value assigned to the dividend shares.
The FMV is transferred from retained earnings to share capital (legal capital). Total equity, however, is unchanged.

7. STOCK DIVIDEND The Effects
On Jan. 1 a company issues an additional 10,000 shares of common stock proportionally to current shareholders on record as of Feb. 1. The Stock is issued Mar. 1. Fair market value is $90,000.
This value is now part of legal capital and must be transferred there from retained earnings.
Note how total shareholders’ equity will remain the same.
The number of shares increases and this means that the book value per share decreases.
Date
Particulars
Debit
Credit
Jan 1
Stock Dividends ,000
Before After Stock Dividend Stock Dividend
Shareholders’ equity
Contributed Capital
Retained earnings
Total shareholders’ equity
Issued shares
Book value per share
Stock Dividends Distributable ,000
Mar 1
Stock Dividends Distributable ,000
Common Stock ,000
$200,000
$290,000
Dec 31
Retained Earnings ,000
$600,000
$510,000
Stock Dividends ,000
$800,000
$800,000
100,000
110,000 $8
$7.27

8. STOCK DIVIDENDS Purposes and Benefits
For company
Satisfies dividend expectations without spending cash
Increases marketability of its shares by increasing number and decreasing price
For shareholder
More shares with which to earn additional dividend income
More shares for future profitable resale, as share price climbs again

9. STOCK SPLITS The Effects
A stock split involves the issue of additional shares to shareholders according to their current ownership percentage.
A stock split has no effect on equity, or ownership control, and therefore requires no journal entry.

10. STOCK SPLIT The Effects
Only the number of shares and book value per share change.
Observe the following 2-for-1 stock split:
Before After Stock Split Stock Split
Shareholders’ equity
Contributed Capital
Retained earnings
Total shareholders’ equity
Issued shares
Book value per share
$200,000
$200,000
Date
Particulars
Debit
Credit
Dec 31
$600,000
$600,000
$800,000
$800,000
There is no journal entry since nothing of financial value changes.
100,000
200,000 $8 $4

11. DIVIDENDS A Summary of Effects
Stock Stock Cash Split Dividend Dividend
Total assets NE NE 
Total liabilities NE NE NE
Total shareholders’ equity NE NE 
Total share capital NE  NE
Total retained earnings NE  
Legal capital per share  NE NE
Book value per share    Number of shares   NE
% of shareholder ownership NE NE NE
NE = No effect  = Increase  = Decrease

12. RETAINED EARNINGS Prior Period Adjustments
A prior period adjustment results from:
The correction of a material error
Occurs after the books are closed, and relates to a prior accounting period.
Changing an accounting principle.
Occurs when the principle used in the current year is different from the one used in the preceding years.

13. RETAINED EARNINGS Prior Period Adjustments
The cumulative effect of the correction or change (net of income tax) should be
Made directly to Retained Earnings;
Reported in the current year’s retained earnings section as an adjustment of the beginning balance of Retained Earnings;
Disclosed in a footnote to the financial statements;
Corrected and restated in all prior period financial statements presented.

14. RETAINED EARNINGS Prior Period Adjustments
Shareholder’s Equity
Contributed Capital
Total Contributed Capital
$30,000
$50,000
Retained Earnings
Retained Earnings, January 1st as previously reported
$30,000
Less: Correction of $10,000 overstated Net Income due to excess recorded sales in prior year less $4,000 of income tax (40% tax rate)
$(6,000)
Cumulative effect of a change in accounting principle net of $10,000 tax expense
$15,000
$9,000
Retained Earnings, January 1st as adjusted
$39,000
Add: Net Income
$150,000
Less: Cash Dividends
(80,000)
Less: Stock Dividends
(20,000)
Change in Retained Earnings for the period.
70,000
$50,000
Retained Earnings, December 31st
$89,000
109,000
Total Shareholder’s Equity
$139,000

15. RETAINED EARNINGS Summary Of Things That Affect It
Debits (Decreases) Credits (Increases)
1. Correction of a prior period error that overstated income
2. Cumulative effect of a change in accounting principle that decreased income
3. Net loss
4. Cash dividends
5. Stock dividends
1. Correction of a prior period error that understated income
2. Cumulative effect of a change in accounting principle that increased income
3. Net income

16. Do Problems:
BE15-1, -2 and BE15-4
E15-2
P15-2A
P15-5A

17. Net Income – Preferred Dividends Number of Common Shares
EARNINGS PER SHARE
Earnings per share (EPS) indicates the net income earned by each common share.
Companies report earnings per share on the income statement
The formula to calculate earnings per share when there has been no change in shares during the year is as follows:
Net Income – Preferred Dividends
Number of Common Shares
Earnings per Share 

18.  PRICE - EARNINGS RATIO
The price-earnings (P/E) ratio helps investors determine whether the shares are a good investment in relation to earnings. It is a per share calculation, calculated by dividing the market price of the shares by its earnings per share.
Market price
per share 
Earnings
Price-Earnings Ratio
A high P/E ratio can be one indicator that investors believe the company has future growth potential.